A federal judge last month set deadlines in a proposed class action lawsuit that accused Herbalife Ltd. of operating a pyramid scheme.
The plaintiff and Herbalife must complete private mediation and settlement discussions no later than Feb. 23, 2015, according to court documents released following a Dec. 9 scheduling conference. U.S. District Judge Beverly Reid O'Connell also set June 16, 2014 as the deadline for a hearing on a request to certify the class.
Denial of class certification would effectively kill the lawsuit because the named plaintiffa former Herbalife distributor whose alleged out-of-pocket expenses total less than USD $4,000could only proceed individually. On the other hand, Herbalife faces potentially millions of dollars in liability if the judge certifies the class of more than 400,000 distributors.
On April 8, 2013, Herbalife's former distributor Dana Bostick filed a complaint against the nutritional products marketer in a California federal court. Bostick claimed he was "doomed from the start by an Herbalife marketing plan that systematically rewards recruiting over retail sales."
Philip Dracht, an attorney representing Bostick with Salt Lake City-based Fabian & Clendenin, said his client spent about $3,439 on Herbalife products, tools, coaching and websites plus incidental expenses.
O'Connell last year denied Herbalife's request to throw out the case although Bostick said he would voluntarily dismiss claims brought under the Racketeer Influenced and Corrupt Organizations Act (RICO).
In the motion to dismiss the case, the court was required to accept as true the allegations in the complaint and expressed no opinion on the merits of Bostick's claim, Herbalife pointed out.
Herbalife still must defend itself against allegations that it has violated Section 327 of the California Penal Code. The statute is aimed to deter schemes in which individuals pay money in exchange for the chance to receive compensation for recruiting others into a network.
Allegations of high prices, wild promises
Bostick argued Herbalife distributors have "little to no opportunity" to earn a profit on Herbalife's products because the multi-level marketing company (MLM) sets the suggested retail price [SRP] at an artificially high rate in order to reward its top distributors with recruiting bonuses.
Dracht told Natural Products Insider Bostick found it difficult to sell Herbalife, especially when others were selling the same products online through eBay and Craigslist at significantly less than the SRP.
"Herbalife sets the SRP so high because for every dollar a distributor pays Herbalife for Herbalife's products (not including packaging, handling, shipping, and tax), Herbalife pays out $0.46 to $0.64 to its top distributors as recruiting bonuses," the lawsuit alleged.
The 68-page complaint described a culture in which Herbalife and its representatives made untamed promises of building wealth and enjoying a lavish lifestyle. According to the lawsuit, most distributors struggle to dump inventory and ultimately fail, with roughly 88% of Herbalife distributors in 2012 earning nothing and just 0.039% bringing home more than $250,000.
In court documents, Herbalife contended Bostick couldn't have been fooled because he agreed that he read a statement that revealed distributors' modest earnings (average of $2,900 in the year Bostick became a distributor; or a medium compensation level of $741).
Herbalife also argued Bostick exerted little effort trying to sell the products"pursuing only impersonal online sales"and made no attempt to return the products, opting to file a lawsuit instead. In Herbalife's "Your Business Basics," the company stresses the importance of distributors leveraging personal relationships.
While Dracht acknowledged Bostick's effort in selling Herbalife products is likely going to be part of the case, he argued the more important question is whether Herbalife violated California's endless chain scheme.
The lawsuit cited a "systematic incentive to recruit other distributors" due to Herbalife's compensation plan.
"The recruiters get paid regardless of whether Dana Bostick sells this product at all much less than at retail price. That particular feature is one that we argue incentivizes recruiting over retail," Dracht said.
Herbalife has rules in place that are intended to encourage retail sales and deter distributors from accumulating excessive inventory.
The lawsuit argued Herbalife's rules don't apply to many distributors, aren't actively enforced by the company and fail to adhere to safeguards that courts have established in pyramid scheme cases.
In court papers, Herbalife declared that it has expressly advised distributors to "be careful not to order more than you can reasonably consume or sell." An advisory on new distributors' expenditures that Herbalife issued while Bostick was a distributor also "expressly counsels Distributors against purchasing large starting inventories, over committing and taking on debt," Herbalife said in court papers.
"Herbalife now has the opportunity to present the court with evidence to demonstrate that Herbalife has the policies in place, such as an effective repurchase program, no restocking fees, a satisfaction guarantee and policies that discourage inventory loading," the company said in a written statement to Natural Products Insider. "Herbalife will establish these facts for the court and seek dismissal of the complaint at the appropriate time."
Bostick is not the only disgruntled Herbalife distributor. Latinos in Illinois and California have been urging local authorities to investigate Herbalife's business model, claiming the company has exploited minorities who are desperate to make a buck.
Others including Congresswoman Linda Sanchez (D-CA) have called on FTC to investigate Herbalife's marketing practices. FTC doesn't comment on whether an investigation is ongoing, and local authorities such as the office of Illinois Attorney General Lisa Madigan have similar policies. Sanchez's office didn't respond to a request for comment on Herbalife.
"The company is actively targeting vulnerable Latinos with little to no business experience, but with strong aspirations to succeed, possibly because studies show Latinos are less likely to report such abuse due to cultural and language barriers," Victor Narro, a professor of labor and workplace studies and an adjunct professor at law at UCLA, wrote in a Dec. 17, 2013 article for the Los Angeles Daily News.
Narro called for California Attorney General Kamala Harris to launch a probe into Herbalife. Harris' office didn't return a phone call seeking comment.
Revenues, shares rise despite allegations
Herbalife has repeatedly assured investors that its business model is legitimate and compliant with applicable laws.
The pyramid scheme allegations brought last year by billionaire investor Bill Ackman have not slowed Herbalife's growth or crushed its market value.
Herbalife's stock price ($80.79 on Jan. 15) has nearly tripled from a 52-week low ($30.84 on Feb. 4, 2013) 11 months ago. Shares reached a one-year high ($83.51) as recently as Jan. 8.
Investors have a reason to be bullish. According to The Wall Street Journal, Herbalife has beat analysts' expectations for 19 straight quarters.
For the nine-month period ending Sept. 30, 2013, net sales grew to $3.56 billion from $3.01 billion in the prior year. Net income increased to $404 million from $351.8 million. (Herbalife will report its fourth-quarter and annual results on Tuesday, Feb. 18).
Last month, a Belgium appeals court ruled that Herbalife is not a pyramid scheme in a 9-year-old case that was filed by a non-profit consumer protection organization. A lower court had reached the opposite conclusion.
Early stages of litigation
In California, lawyers are in the early stages of what is likely to be months of haggling over requests for documents, questioning of potential witnesses and other issues leading up to the hearing for class certification.
Nobody has been questioned yet in a deposition. But last month, Bostick's lawyers requested documents related to such issues as Herbalife's marketing practices, its statement of average gross compensation and its shipping and return policies, Dracht said.
Herbalife is due to produce the documents Jan. 21 or responses to the plaintiff's requests, he said.
"We anticipate we are just going to get responses," Dracht said. "We are going to have to fight tooth and nail to get every document we can."
Dracht noted the two sides are negotiating a protective order to keep documents confidential.
The proposed class action lawsuit is Dana Bostick v. Herbalife International of America et al, CV 13-02488-BRO, Central District of California.
Plaintiff is represented by Dracht and Thomas Foley with Santa Barbara, CA-based Foley Bezek Behle & Curtis, LLP. Herbalife's counsel includes Jonathan David Schiller, Jonathan Sherman and Karen Paik of New York-based Boies Schiller & Flexner LLP.
According to Schiller's bio, he is lead counsel for Herbalife in its dispute with Ackman over the pyramid scheme allegations. He's also responsible for "protecting Herbalife's interests in related litigations and government relations matters all arising out of the pyramid scheme allegations."
Last year, Herbalife acknowledged the Securities and Exchange Commission (SEC) requested information on its business and financial operations after it asked for a meeting with the agency's staff.
Herbalife said it is unaware of any other class action lawsuit in the United States that is related to its marketing plan.
Such a complaint would likely be filed in Los Angeles where Herbalife is based. Dracht said an agreement distributors sign with Herbalife requires that they file lawsuits in LA, and the contract dictates that California law governs the disputes.